Steve Seelig is Senior Director, Executive Compensation and Stephen Douglas is Senior Legislative and Regulatory Advisor, Technical Services at Willis Towers Watson. This post is based on their Willis Towers Watson memorandum and is part of the Delaware law series; links to other posts in the series are available here.

The Delaware Chancery’s refusal to dismiss a derivative allegation in a suit claiming that Goldman Sachs directors were paid excessively may soon provide a decision that offers companies guidance on setting board of director pay (Stein v. Blankfein, Court of Chancery of the State of Delaware, C.A. No. 2017-0354-SG (Del. Ch. May. 31, 2019). This guidance may come despite the court’s initial doubts that the facts, when more fully developed, would yield a holding against Goldman.

If the case is not settled before the next phase of the case, the Chancery’s application of the “entire fairness” standard may provide greater clarity on how directors are paid and whether pay levels are excessive. The “entire fairness” standard, as applied to director pay setting, was articulated in the 2017 Investor’s Bancorp case, and has a standard that is less differential than the “business judgment rule”. (See “Delaware Supreme Court ruling moves the goalposts on director compensation,” Executive Pay Matters, February 16, 2018).

The initial court decision raises several notable issues.

Shareholder waivers

Goldman’s shareholder-approved equity plan included a provision that purported to waive a shareholder’s right to sue the directors for violating their duty of loyalty regarding setting their own pay. The court rejected this notion, with Vice Chancellor Glasscock writing: “I am dubious that a majority of stockholders can waive the corporation’s right to redress for future and unknown unfair self-dealing transactions.”

The ruling offered some perspective on how blanket waivers could work and the reasons for having them in equity plans. It was suggested that the waiver language could apply to awards made to Goldman employees and officers by directors (the bulk of grants made under the plan) because they’re not acts of self-dealing and would be reviewed under the protections of the “business judgment” rule.

For directors setting their own pay, the ruling suggested that a blanket waiver could work if stockholders were explicitly informed that director grants would be self-interested transactions subject to an “entire fairness” review and that the stockholders would be waiving their right to redress. A waiver might then hold, even if director grants are unfair to the corporation, as long as the directors had not acted in bad faith. In addition to including “meaningful limits” for their director grants, companies may want to ask counsel if inclusion of these waivers helps with defending future suits brought in the employee pay setting process.

The “entire fairness” standard and the Goldman suit

Goldman’s motion to dismiss was denied because the court viewed the facts in favor of the plaintiff, presuming that claims of excessive compensation could be proved even though it indicated that they weren’t particularly strong.

The plaintiffs argued that the Goldman board’s pay levels constituted unfair dealing because they averaged nearly twice that of peer companies’ directors, but that shareholders got no additional value from that pay premium as Goldman’s profitability was in line with its peers. The opinion found that merely setting salaries above the peer average is not evidence of excessive compensation—noting that if it were, half of all companies would be overcompensating their directors.

Goldman countered that even though its largely stock-based compensation is about 1.7 times the average peer salary, the stock’s restricted nature makes it is less valuable than its trading value. It also argued that its director compensation is reasonable, and for support, noted that it had followed its outside compensation consultant’s recommendation. Finally, Goldman argued that its directors have extensive duties in addition to “official board meetings,” and that compensation less-than-double its peers isn’t unfair to the corporation. The court did not opine on these arguments, which will be fleshed out as the case moves forward.

The Chancery, however, was unmoved by the Goldman director’s argument that letting this case move forward will encourage a massive filing of director compensation strike suits, mostly because the amounts at issue are not that large and the plaintiffs’ costs to develop a record for trial will be significant.

What we will, won’t and could learn

Will learn

The court will hear more about the pay setting process, particularly the question of how the board interacts with its pay consultant. We’ll see more about the process by which the consultant developed its recommendations, including its selection of peer groups, which the court will either endorse or find faulty. This may change how the current process works at other companies if the plaintiff wins, or could provide a roadmap of practices to be used at other companies if Goldman wins.

Won’t learn

The waiver issue for executive pay suits will not be litigated in this case, so it remains to be seen whether companies will include blanket waivers for executive pay-setting activities, and then whether a court will find it to be binding when future executive pay suits are brought.

We won’t learn any more about what type of proxy disclosure to avoid, as allegations that Goldman made imprecise or generalized proxy disclosures regarding the pay setting process and Internal Revenue Code section 162(m) deductibility were dismissed.

Could learn

We could learn more about what the court considers an appropriate pay level, or at least whether the pay levels set for Goldman directors were appropriate under the circumstances. We might learn whether the court considers value differences between cash and equity grants, particularly when the latter are restricted, which could provide guidance on measuring equivalency

Setting Directors’ Pay Under Delaware Law 2019-09-18T08:53:33-04:00 2019-09-18T08:53:33-04:00Harvard Law School Forum on Corporate Governance and Financial Regulation

One Comment

It appears the only way to avoid the application of entire fairness to the compensation of outside directors is to have the shareholders vote to approve that compensation or at least the formula that will set that compensation.